There has been much discussion recently of the importance of “preserving” Fed independence. But is the Fed independent? Independent of what? Jerry concentrates on the link between the Fed’s monetary policy and the Treasury’s fiscal policy. Consider:

Today, however one parses the term, the Federal Reserve is not now independent. It has voluntarily relinquished the very independence it secured in 1951 by entering into a modern version of the bond support program. That is what the so-called zero interest rate policy amounts to, reinforced by the quantitative easing implemented through QE1 and QE2.

The Fed is committed to holding interest rates at a very low level by purchasing as much Treasury debt as necessary to maintain those interest rates. That is precisely the position the Fed found itself in before the 1951 accord.

Monetary policy once again is not independent of fiscal policy. None of the Fed’s critics can do as much harm to the institution’s independence as it has done to itself.

The whole article is quite interesting. It raises importance questions not only of economics but of politics as well.

Dan Klein responds, on the meaning of economic coordination, mostly to Israel Kirzner, and secondarily to several others, including me. Here is Klein’s abstract:

The Fall 2010 issue of the Journal of Private Enterprise featured a complicated set of papers. The lead article was a long paper by Jason Briggeman and me, on Israel Kirzner’s work on coordination and discovery. The thrust of our paper was an affirmation of Kirzner’s central claims, but with two alterations. First, we propose that the coordination that figures into the central issues ought to be understood as what we call concatenate coordination. Second, the central statements at issue ought not be asserted as holding 100 percent of the time, but rather should be by-and-large statements, making for a strong presumption, not a categorical result. Israel Kirzner then replied to our paper. The pair of papers was then the object of commentary by Peter Boettke and Daniel D’Amico, Steven Horwitz, Gene Callahan, and Martin Ricketts. Here, I respond to Kirzner, and, in an appendix, more briefly to the others.

For years, Radley has documented shocking problems in the American criminal justice system from no-knock warrants, to the snitch system, to forensic science. He contributed to the July 2011 special issue of Reason magazine on “Criminal Injustice.” The criminal justice system is the great fulcrum point where the power of the state meets the people. We need to be more conscious of the problems of our criminal justice system and the risks to our liberties created by those problems. And liberty loving scholars need to think harder about the nature of the problem and what to do about it.

For those who have access to the Financial Times, a must-read is the opinion piece by Saifedean Ammous. Saif attended our NYU colloquium regularly during his last year as a graduate student at Columbia University. Congratulations. See the FT online here.

Friends of ours, including Richard Ebeling, Steve Horwitz, Gerry O’Driscoll, George Selgin, and Larry White, and others, are contributors to a new blog on “Free Banking”.

Quoting its credo,

“The Free Banking blog is a venue for leading free banking advocates to share their insights with the world. This illustrious cast includes academics, public policy experts, government officials, and rabble rousers. Guest bloggers will feature financial gurus, entrepreneurs, historians, celebrities, and many other different perspectives.
We hope that making these ideas and conversations more accessible will help educate the lay public, amateur economists, and influential intellectuals. Most importantly we aspire to promote and facilitate the transition to free banking in both developed and developing countries.”

We know from Wicksell’s (1898) Interest and Prices, there is something important about the interest rate that balances saving and investment in an economy over time. This equilibrium interest rate is called the “natural rate of interest”. When market interest rates are below the natural rate, an unsustainable credit boom which distorts the production structure in the economy and inflation are the result.

In line with this idea, most economists agree – today – that the Fed held interest rates “too low for too long” following the burst of the dot-com bubble. As expected, this contributed to a credit boom in the US economy. With the emergence of the crisis, the Fed lowered interest rates to stabilize the price level, financial system and output. Yet, a year of recovery is over and interest rates are still low. What about the natural rate today? Continue reading →

Ronald Coase was recently interviewed by Wang Ning on the occasion of Coase’s 100th birthday and to discuss the Ronald Coase Society in China. There is a good deal that is interesting about the interview, especially to those interested in China. However, here I’d like to point to a number of statements Coase makes of more general interest. Continue reading →

In the September 15th Wall Street Journalthere is a chart that gives a quick view of the “pragmatic” expansion of entitlement programs that has led to where we are now. Who could have predicted the long-term consequences of case-by-case pragmatic problem solving? I suggest Herbert Spencer, Ludwig von Mises, and Friedrich Hayek. Continue reading →

Richard Ebeling, as usual, does an excellent job of showing how the inability to see macroeconomic phenomena as the outcome of complex micro-processes leads to poor policy prescriptions. Take a look at his response, at EconomicPolicyJournal.com edited by Richard Wenzel, to a post by Tyler Cowen at Marginal Revolution. The upshot is that the subsidization of employment during a recession is a bad idea.

What has been disappointing about the recent stimulus vs. austerity debate is the recycling of arguments that have been gone over many times before in many newspapers and blogs. The debate has become tiresome and unenlightening.

The major feature of the debate that is responsible for the lack of enlightenment is, well, its unrelenting macro-aggregate character. The main variables are excess demand for goods, excess supply of financial assets, total government spending, deficit to GDP ratios, government debt to GDP ratios, the confidence of economic agents in government bonds (as measured by yields), and so forth.

Is there anything important going on beneath the surface – factors that have a more direct causal relationship to the decisions of real economic agents?

This is not an orthodox Austrian approach. In fact, Cowen criticizes that version. However, the “new Austrian” inspired version he presents seems especially relevant in view of the widespread, but not uiversal, agreement that the pre-recession period of very low interest rates contributed to the search for yield and greater risk taking. As the title indicates, Cowen’s theory emphasizes the importance of low interest rates on risk-taking.

This book appears in the Routledge series, “The Foundations of the Market Economy” edited by Larry White and me. Tyler’s book is well worth reading as are many books in this series (now approaching thirty books).

Summer reading is eclectic and before getting to my second installment of notes on This Time is Different, I want to recommend a non-economics book. A Chance in Hellby Jim Michaels is a riveting account of how the military and political situation turned in Anbar province in Western Iraq. It is first and foremost an account of courage: that of a minor Sunni Sheik, Abdul Sattar Bezia, who led an uprising against al-Qaeda, and the American officers, led by Col. Sean MacFarland, who backed him.

Together they snatched victory from defeat in the battle for Ramadi. The much-discussed troop “surge” came only one year later, and Ramadi was already largely won. It is questionable whether the elements that made for that victory can be replicated in Afghanistan. But reading this book is the best way to understand what did happen.

Amity Shlaes has written an enlightening op ed on “FDR, Obama and ‘Confidence’” in today’s Wall Street Journal. She details how FDR destroyed investor confidence in the 1930s by his incessant attacks on business and businessmen, and by his policy inconsistency.

Treasury Secretary Morgenthau at first served as FDRs “yes” man and cheerleader. But he came to realize how destabilizing FDRs actions were. The Treasury Secretary began resisting his boss’s policies. She writes that Morgenthau “found an unlikely supporter” in John Maynard Keynes. Keynes wrote a critical letter to FDR about his persecution of utilities. “What’s the object of chasing them around the lot every other week?”

Market confidence returned when FDR concluded he needed to make allies of business once he decided he needed to plan for war. She concludes: “Perhaps Mr. Geithner might like to read up on Morgenthau’s progress. Treasury secretaries who forget the past condemn us all to repeat it.”

My summer reading actually began in the spring and included a number of books written on the financial crisis that I was asked to review by various publications. My reviews will appear in fall issues. I can report that a number of the books written for the general public are quite good. These include, but are not limited to, works by John Taylor, Thomas Sowell and George Melloan.

The discussion of the Hayek-Keynes letters of 1932 in The Times of London continues in 2010 in the Wall Street Journalin today’s issue. The opinion piece is by Jerry O’Driscoll, a frequent blogger at ThinkMarkets.

In Tuesday’s Wall Street Journal, George Melloan makes the case that savers and investors lose under the Fed’s low-interest policy. He also argues that the policy leads to greater risk-taking by those pursuing yield. Presumably it is leading to the next asset bubble. But where?

The great political superstition of the past was the divine right of kings. The great political superstition of the present is the divine right of parliaments. The oil of anointing seems unawares to have dripped from the head of the one on to the heads of the many, and given sacredness to them also and to their decrees.

……

When that ‘divinity’ which ‘doth hedge a king’, and which has left a glamour around the body inheriting his power, has quite died away – when it begins to be seen clearly that, in a popularly governed nation, the government is simply a committee of management; it will also be seen that this committee of management has no intrinsic authority.

The inevitable conclusion will be that its authority is given by those appointing it; and has just such bounds as they choose to impose. Along with this will go the further conclusion that the laws it passes are not in themselves sacred; but that whatever sacredness they have, it is entirely due to the ethical sanction – an ethical sanction which, as we find, is derivable from the laws of human life as carried on under social conditions.

And there will come the corollary that when they have not this ethical sanction they have no sacredness, and may rightly be challenged. The function of Liberalism in the past was that of putting a limit to the powers of kings. The function of true Liberalism in the future will be that of putting a limit to the powers of Parliaments.

An interesting discussion has begun at Marginal Revolution on “Benthamite utilitarianism.” It started with a small comment I made on Tyler Cowen’s remark regarding the discussion of Robert Frank’s position goods idea. Then Tyler responded in a post. And then I made a comment. It is all here.

Discussions of this subject can be interminable. So perhaps just a little is best.

The New York Timesmagazine has an interesting, if somewhat uncritical, article on Cass Sunstein, the Obama regulation czar. The “best” part is the section about me:

Some scholars dislike the strong, if subtle, governmental hand that is embedded in this last proposal. It seems more forceful than a nudge. “Once you get to a point where you have automatic enrollment, you raise the question, What kind of fund?” Mario Rizzo, a professor of economics at New York University, says. “The problem is that if you were enrolled automatically, you could complain later that you’d been put into either a too-risky or a too-conservative fund. So then you micromanage that and you say you have to have a balanced fund. But pretty soon you’re on a slippery slope, where you’re dictating people’s retirement choices.” Rizzo told me about an academic study of gift-giving that found that most people would value cash more highly than the gifts they get for holidays; if even your friends and family can’t figure out what you want, he asked, how can a distant bureaucrat? “Sunstein is very taken with the need for experts,” Rizzo says. “But it turns out experts are subject to these cognitive quirks, too.” Continue reading →

Today I reread F. A. Hayek’s Nobel Lecture, “The Pretence of Knowledge.” Hayek was awarded the Nobel Memorial Prize in 1974 and delivered his lecture on December 11, 1974. I was amazed at how modern it was, and appropriate once again for the times.

The 1970s were terrible times: stop-go demand management policies had produced stagflation that would continue for the rest of the decade. Hayek said that “we have indeed at the moment little cause for pride: as a profession we have made a mess of things.” He charged that the mess had been produced by policies the majority of economists “recommended and even urged governments to pursue.” Continue reading →

Did you ever wish that you could get Carl Menger’s comments and approval of your work? Maybe not. But the next best thing (or even better) is the essay contest named after the founder of the Austrian School of Economics. If you are an undergraduate student, take a look here.

I extend Hayek’s argument about prices as information transmitters to other essential elements of a market economy, such as accounting statements and representations made to customers. Prices and interest prices were distorted in the boom, but so, too, accounting statements and representations made by borrowers to lenders, and lenders to borrowers.

The free market depends on truth telling, the accuracy of information and honest pricing. Instead, as I argue, we are becoming “An Economy of Liars.”

My imagination was captured by Jean-Paul Carvalho and Mark Koyama’s paper “Instincts and institutions: the rise of the market.” Carvalho and Koyama identify and close an important gap in our understanding of the evolution of trade. Thanks to Greif, Milgrom, North, and others, we have a pretty good idea how medieval institutions promoted trade and enabled the emergence of capitalism. Thanks to Cosmides, Fehr, Bowles and others we have a pretty good idea how our evolved psychology supports the institutional fabric of modern capitalist economies. What we have not understood, however, is how our evolved psychology could be consistent with the emergence of the medieval institutions that promoted trade early on. Continue reading →

My frequent coauthor, Glen Whitman, has the lead essay on new paternalism at Cato Unbound this month. There will be responses by Richard Thaler (Chicago), Jonathan Klick (U of Penn), Shane Frederick (Yale).

This is the most important thing you can read this month — better than anything anywhere else in the blogosphere, world wide web, and all traditional media publications. Except posts at Think Markets, of course.